Principles to Assist in Financial Decision making

Principles to Assist in Financial Decision making (from The Big Picture) In Apprenticed Investor Investing Psychology/Sentiment

Some smart, common sense advice from a financial planning site: Principles to Assist in Financial Decision-making:

• Plan ahead. Give yourself time to realize your goals. Proactive instead of reacting to events
• Life is full of tradeoffs. Working is trading your time for groceries. In deciding how much money to save, consider the real costs.
• Consider Opportunity costs. The opportunity cost of doing something is highest-valued activity you might have done instead.
• Think on the margin. Decisions should ignore sunk costs and weigh the marginal costs and benefits. If I take this action, will I be better or worse off than if I do not take this action?
• Real returns matter. Your real income, real wealth, and real rate of return measure your purchasing power, adjusted for inflation.
• The time value of money. In evaluating cash flows, we need to convert future dollars into a present value, which can be compared to the current price of the cash flow.
• The power of compound interest. Earning interest on interest turns seemingly modest saving into remarkable wealth, an insight that Albert Einstein reportedly described as “the greatest mathematical discovery of all time.”
• Leverage is a two-edged sword. Debt is one way of creating leverage, in which a relatively small investment reaps the benefits or losses from a much larger investment.• Efficient markets. Markets are "reasonably efficient" -- but not perfectly so. Prices reflect informed opinions of many observers. If you think the price is wrong, you should consider whether you know more than the market.
• The future is uncertain. Do not overestimate your ability to predict the future. Place the most weight on the future that is most probable, but do not ignore other scenarios.
• Be resilient. Don’t despair when the unexpected happens. Learn from your mistakes, but don’t be obsessed with the past, which cannot be changed.
• Diversification reduces risk. Prudence is a well-diversified portfolio of eggs in several, very different baskets.
• Risk can be rewarding. In a risk-averse world, safe investments will have relatively high prices and low anticipated returns; risky investments will have relatively low prices and high anticipated returns.
• Think differently. If the herd-like instincts of most investors sometimes push asset prices to unreasonably high or low levels, then consider a contrarian strategy.
• Beware of people peddling products. Someone who gets a commission for selling you something often has a conflict of interest.
• If it sounds too good to be true, it probably isn’t true. Someone selling get-rich-quick advice evidently believes he can make more money from selling his advice than from following it.